British Airways is facing its most turbulent time since the crisis immediately after the terrorist attacks of 11 September 2001. Doing business in probably the most competitive of global industries, and plagued by chronic labour relations problems, BA has now found itself hamstrung by a third problem, and potentially its most intractable - the huge pensions deficit that is acting as a dead weight on the airline's plans for future expansion.

From a financial point of view, BA - still Britain's flag-carrier, if no longer the 'world's favourite airline' - is barely an aviation business at all. With pension liabilities of some £12bn, it is more a gigantic benefit provider, funded by a relatively small airline (turnover £7.7bn in 2005). BA's pensions bill last year was £235m, roughly half of last year's pre-tax profits.

BA has the dubious distinction of being the FTSE 100 company with the biggest pensions deficit (some £2bn before tax at the last count) compared to its market capitalisation - nearly £4 billion last week. And those ratios are probably set to deteriorate even further in June, when BA gets some idea of its current actuarial valuations - the last was in March 2003.

It has been called a 'flying pension fund', but if so it is struggling to stay in the air. The BA finance director Keith Williams, echoing his boss, chief executive Willie Walsh, is adamant that the pension problem has to be fixed 'once and for all - we have to resolve the situation before we can consider buying more aircraft or making further investment.'

The effect of the financial burden on the airline's core business is being felt more strongly all the time. BA is quick to reject City gossip that the pensions regulator, David Norgrove, has put a block on buying new aircraft because of the pension deficit, but that has not stopped the rumour-mill. Specifically, it is suggested that a recent proposal to buy new Boeing 747s was blocked by Norgrove.

'That is not true,' says a BA spokesman. 'We have no immediate need to buy new planes, and will not be doing so for at least two years, and by then the pensions problems will hopefully be sorted out, as well as the move to Terminal 5. Our aircraft fleet is comparatively young, and the oldest 747 we have is from 1986 - not old for an aircraft.'

But BA has admitted it must soon begin to consider renewing its long-haul fleet. Last month the airline announced it had secured options on 10 Boeing 777 planes for delivery starting at the end of 2008 - the first time since 1998 that BA has placed new orders for aircraft.

BA operates 57 Boeing 747 aircraft with an average service length of 12 years. Its 21 Boeing 767 aircraft have been flying for an average of 13 years, close to the industry average for this type of plane. The average age of BA's fleet as a whole is 10 years.

A BA executive says: 'Our assumption is that in order to purchase new or replacement aircraft we would have to first resolve the pensions deficit. If we don't do that, we would not be able to get the best rates in the market, and our credit is still rated as "junk".'

It seems Norgrove has not been put to the test by a BA request to expand the fleet, but it is also pretty certain what his answer would be if Walsh wanted to splash out, with new Boeing 747s costing around $250m apiece.

Nonetheless, the issue of 'pensions or planes' will not go away, especially this week when trade union representatives meet to consider their response to BA's proposals to tackle the dilemma . 'We've heard all this rhetoric about "pensions or planes" for a while now,' says a source from the biggest union at BA, the Transport and General Workers' Union, 'and we assumed it was all just part of the softening up process. We heard it with raised eyebrows and a lot of cynicism, which is what we're used to with BA.'

Walsh's plans were met with hostility by the unions when they were announced last month. They were: an increase in the retirement age, ultimately to 65, in an industry which has traditionally enjoyed much lower levels; capping pensionable pay to inflation levels regardless of wage increases; and making a £500m pension payment from BA conditional on all other parts of the package being approved. All these elements - regarded as essential by BA - were guaranteed to upset the notoriously touchy BA workforce.

'We did not like it at all, and still regard it as unacceptable,' says a union source. 'We have asked for details of their financial plans, future investment projections and capital spend. We've seen 13,000 jobs disappearing, increased operating margins, higher profits and reduced debts. In those circumstances, is this the best they can do? It's in nobody's interests to bankrupt an airline, but we have to look after our members interests.'

The pilots' union, Balpa, which is particularly incensed about the retirement age increase (pilots currently finish at 55), has also adopted a hostile stance, threatening industrial action if the plan is forced through.

Confrontation seems almost inevitable. Williams says: 'We will consult, and we will listen to what they have to say,' leaving open the possibility that there could be room for compromise. But others at BA are less accommodating: 'This is a process of consultation, not negotiation,' said a senior executive. 'I don't think there is much room to depart from the proposals.'

One option not open to BA is that favoured by its American rivals - bankruptcy. US airlines frequently take advantage of the country's Chapter 11 insolvency laws to unload their pension obligations and emerge unencumbered after a period of protective administration. Williams says: 'To go into administration would mean closing down the fund, which would cost between £3-4 billion. It is not an option.'

And there is a different business ethic surrounding bankruptcy in Britain, even in the more benign current legislation. 'To the layman, it is the same as going bust. All our customers would take fright, staff morale would plummet and our routes would be at risk,' said a BA executive.

Some City experts believe administration is a viable proposal. Donald Duval, chief actuary of Aon Consulting, says: 'BA is in an unusually difficult position. It just cannot afford to be distracted from the operating business by this huge financial burden.'

So the stage is set for weeks of tense negotiation and, probably, dispute with the unions. The talks will be aggravated by the need to agree new working practices ahead of the move to Terminal 5, set for 2008, and the ongoing job cuts programme. 'If you're asking me whether you should book for the August bank holiday weekend, I'd say get the train,' says a union source.